The basic thrust of the author’s position is that Asian currency interventions will create inflationary pressures, which would allow world economies to slowly escape recession. Currency interventions are also favorably compared to eliminating the gold standard during the Great Depression.

Unfortunately, the author might be missing the underlying reason why the elimination of the gold standard allowed for economic recovery in the Depression. Instead, the currency interventions might be better compared to the disastrous Smoot-Hawley Tariff Act in the United States.

It wasn’t merely that the elimination of the gold standard created inflation. The underlying issue was that the gold standard created arbitrary and inflexible monetary policy during the Depression. By doing this, it prevented market forces from operating and money supply was artificially suppressed. As money supply was distorted, the market was deterred from reaching an optimal growth result.

There were only two ways to fix the imbalance: (a) discover a large amount of new gold deposits and mine them or (b) eliminate the gold standard. As gold is a scarce good and world population was rapidly rising in the late 19th and early 20th Centuries, (a) was becoming an increasingly difficult proposition. For this reason, elimination of the gold standard was the only real solution. And it worked magnificently, as every economy that eliminated the gold standard was able to greatly ease the Depression. In fact, China, which was on the silver standard, was almost able to miss the Depression entirely.

The current situation has a lot of parallels, unfortunately. Mercantilistic currency interventions artificially constrain money supply, just like the gold standard did during the Depression. More importantly, the interventions fuel large trade imbalances.

Essentially, we're cheating the free market. It doesn't matter if an American or Spanish firm can more efficiently manufacture widgets than a Japanese or Chinese firm --- by intervening in the currency markets, it is arbitrarily dictated that the Japanese or Chinese firm wins out. However, the issue with this is that it produces inefficiencies. It might even be creating negative growth because more efficient firms are being pushed out of the market in favor of more inefficient firms.

On the other side of the equation, the currency interventions are actively harming Asian consumers. While these interventions can help create GDP growth, they do so at the expense Asian wage-workers. Wealth is redistributed primarily to two groups: (a) American consumers and (b) the owners of capital of Chinese and/or Japanese exporters.

Or in other words, these currency interventions create over-consumption in the US and under-consumption in East Asia. Equilibrium is not allowed to occur and sub-optimal growth (or even economic contraction) results as economic efficiencies are destroyed.

Just to make things worse, the constant tug of war between market forces and the interventions creates greater economic instability that produces huge bubbles and busts. While Alan Greenspan and Congress should be given some credit for helping to create the housing bubble in the US, Chinese currency policy also deserves its share of the blame, as the constant currency interventions artificially lowered interest rates in America, helping provide more fuel to the housing boom.

It's worth noting that in spite of Chinese and Japanese currency interventions, both nations have eventually run into a brick wall where they have deprived their consumers of so much of their 'earnings', that they simply cannot afford it any more. This is happening in China right now, as Chinese workers are forced to demand greater compensation in order to deal with rising costs-of-living It also appeared to occur in Japan in the mid-80’s before the Plaza Accord, as Japanese economic growth had been waning after a nearly three-decade long boom.

For these reasons, the currency interventions might be more like the Smoot-Hawley Tariff than the elimination of the gold standard. Smoot-Hawley attempted to fix global trade imbalances by promoting trade barriers that created more imbalances. Inevitably, European nations retaliated against the United States and the tariff only exacerbated the crisis.

While currency interventions have a different economic affect, the end result is the same: economic efficiencies are deterred and sub-optimal growth becomes more likely. Until the international currency system is reformed and these mercantilistic trade wars in Asia are eliminated, we may continue to see a poor worldwide economic environment.

Unfortunately, the author might be missing the underlyingreason why the elimination of the gold standard allowed for economic recovery in the Depression. Instead, the currency interventions might be better compared to the disastrous Smoot-Hawley Tariff Act in the United States.

It wasn’t merely that the elimination of the gold standard created inflation. The underlying issue was that the gold standard created arbitrary and inflexible monetary policy during the Depression. By doing this, it prevented market forces from operating and money supply was artificially suppressed. As money supply was distorted, the market was deterred from reaching an optimal growth result.

This analysis might be true, if the USA and European countries were actually on a gold standard when the Great Depression started. The USA went off the Gold Standard in 1926 (and briefly in 1917). Europe, en masse, went off the Gold Standard in 1914. Unfortunately, European governments tried to peg gold at its pre-war price after the war, rather than confronting the reality of inflated currency.

So, the real reason for the Great Depression was not the inflexibility of a standard no one followed in the first place. The Great Depression was caused by economic reality flying in the face of bureaucrats and bankers that wished to delay the economic pain of war debts indefinitely.

Or one could say that inflation and paper money caused the Great Depression.

Or one could be even more honest and say that government leaders and bankers caused the Great Depression.

But it certainly had nothing to do with a Gold Standard that nobody followed or any 'market failure' propaganda promoted by government.

There is also no link between a shrinking money suppy and Depression. Friedman's correlation conclusion suffers from small sample size, a correlation that disappears as soon as you widen the view. (Well, that, and correlation is not causation. But other than that, how can we not love him? It's hard to say that a gentle friend of liberty was wrong. Shame.)

Currency intervention is monetary policy. Monetary policy is currency intervention. It seems kind of silly, almost witch-doctor talk, for guys like Krugman to bash China for currency intervention, but advocate that the Federal Reserve inflate here or there. What does he think that is? That's currency intervention. Duh.

A gold standard leads to deflation whenever an economy using the gold standard grows faster than the gold supply. When an economy grows faster than its money supply, the same money must be used to execute a larger volume of transactions. The only ways of achieving this are for the money to circulate faster or to lower the cost of the transactions. If deflation drives costs down, the real value of each unit of money goes up. This increases the value of cash, and decreases the monetary value of real assets, since the same asset can be purchased with less money. This in turn tends to increase the ratio of debts to assets . For example, assuming interest rates remain unchanged, the monthly cost of a fixed-rate home mortgage stays the same, but the value of the house goes down, and the value of the money required to pay the mortgage goes up. Thus deflation rewards cash savings.

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From the Wiki.

I also don't get how whereaminow can say that we weren't on the gold standard at the start of the great depression.

Also from the Wiki:

The gold standard limited the flexibility of central banksmonetary policy by limiting their ability to expand the money supply, and thus their ability to lower interest rates. In the US, the Federal Reserve was required by law to have 40% gold backing of its Federal Reserve demand notes, and thus, could not expand the money supply beyond what was allowed by the gold reserves held in their vaults.[12]

And I do believe that world economic growth far exceeds the amount of gold being mined. So, a gold standard now would be very deflationary (because there would not be enough currency to supply the growing number of transactions).

I can say that we weren't on a gold standard because if you create more money than the gold standard allows, you are no longer on a gold standard.

In the mid 1920's England was near bankruptcy (or bankrupt). They had been off the gold standard since WWI. When they attempted to return, they decided to peg the Pound at the old gold/pound ratio. This led to a flight of gold out of the country, mostly to America. Instead of re-pegging the Pound and admitting bankruptcy, the Bank of England and the Federal Reserve decided it would be best to inflate the dollar, hoping that this would stop the flow of gold from England to America. When the Federal Reserve enacted this plan in 1926, it was no longer operating on a gold standard.

In other words, they broke the law. But you can't blame the law for the problems that followed. The inflationary actions of the Fed created the stock market bubble of the late 1920's. Therefore, the Federal Reserve was most directly responisble for the crash, and therefore should be blamed above any for the Great Depression, certainly more so than a law that wasn't followed.

Oh, and I apologize for hijacking the thread and turning it into a GD discussion. (I haven't time to blog lately and it's frustrating me!)

I agree with the remainder of Jakila's analysis. I know that economist Robert Higgs has laid a lot of blame for the reluctance of businesses to spend on "regime uncertainty", the idea that they don't know what economic intervention will come next. This makes them reactive rather than proactive. China's currency interventions are designed to counteract this problem but will only result in more problems.

My initial reaction to the US Treasury's escalating rhetoric toward Chinese currency management was one of great dismay. My first thoughts were thoughts of retaliation and an escalating tariff war, a view which Jakila appears to share. We as Americans would be most naive to expect a unilateral acceptance of tariff penalties by the Chinese and numerous US firms will pay the price for Chinese retaliation when it comes to pass if we allow our leaders to go down this ominous road.

There are no free lunches. There never have been and there never will be. Populist rhetoric may be catnip for incumbent politicians immediately before what is widely expected to be the most contentious election cycle in recent memory, but it's counterproductive. The real problem (and there is pun intended there) is that there is a huge input cost gap between Chinese and American manufactured goods in terms of real wages. This is not a moral dilemma, it is a pragmatic reality. Until that gap closes this will be an ongoing and intractable problem. Either US workers need to accept lower wages or the bargaining power of the Chinese workforce needs to rise to close the gap or some combination of the two. This is happening now, I believe, but it needs to be allowed to continue and run its course. It’s not at all dissimilar to the post Industrial challenge that America posed to Great Britain about a century ago. The parallel is rather uncanny actually. As much as we'd like to believe our policy makers can wave magic wands in the currency markets and make all of our financial hardships go away, this is a sheer fantasy and any such approach is doomed to fail. This will only create more structural problems and asset price distortions then it will solve and the world economy will spiral into an even deeper state of dysfunction until widespread hostilities break out. Furthermore, one currency intervention only begets another, thereby nullifying the first and rendering it completely ineffective.

It is my sincere hope that OUR policy makers in the US are not trying to clandestinely manufacture inflation here by making Chinese imports more expense in an attempt to thwart deflation in the US. The bond market is too smart to let that sail by unnoticed and bond traders will react violently to this if they get even the faintest whiff of this wafting out of Washington. Bill Gross, after his disappointing visit to Washington recently will be among the first to levy the punishment. Once the risk free rate snaps (the rate to which all assets across the risk spectrum are pegged by the way) then the whole house of cards across the entire risk spectrum will come crashing down upon itself.

This is not something to wish for; this is something to fear gravely and encourage our leadership NOT to pursue.

On the other hand, I suppose that is the corrective action that's necessary to restore balance and reengage the private sector.

If you give the private sector enough of a discount for owning risk that and only that will prompt them to enthusiastically come out of cash and bonds and participate again in risk assets in a meaningful way as the likes of Jeremy Siegel, Warren Buffet, Jeffrey Immelt, Steve Ballmer and many, many others have all seemed to be trying to jawbone average Americans into doing recently. It wreaks of an all out, last ditch coordinated PR effort to appeal to American patriotism and nationalistic sentiment right around 9/11 and just before the feared October period in the US market. I find it a rather blatant and despicable co-opting of the emotions and sentiments attached to that atrocity to suit their own ends and the expense of average unsuspecting persons. I don't mind publicly admonishing them for that, either. We all need to take our lumps and realize that we've been getting a free ride for years largely powered by smoke and mirrors in the form of lax fiscal and monetary policy. Weaning Americans off the expectation of government or FED rescue at the first sign of adversity is going to be very difficult, indeed, but it’s going to be necessary if we want to promote and protect the future prosperity of our nation.

Do not be fool enough (small “f”) to fall for pad answers and easy solutions. The prosperity of the Chinese is rising relative to the US because they deserve it. They work longer and harder then we do. If we out produce them then we can enjoy the same benefits again but it’s going to mean making a commitment to reducing our leisure time and increasing our work ethic to levels that will seem puritanical to most. It will be difficult, but it’s not impossible.

Rather then aiming to take the easy road and subvert our competitors with policy barriers, political pressure and trade blockades, why don’t we take the higher road and seek to outwork and outproduce them? Or are we now afraid of a little competition?

I don’t see why we can’t all work 11 or 12 hour days with little to no vacation. What’s so bad about that? That’s how a true wealth of nations is created.

It’s certainly NOT created by printing money and doling it out. That much I know for sure.

Great post. And definitely too cheap Chinese currency is a part of the puzzle. essntially, chinese workers subsidise american consumption.

But there are too many other things going on also. If suppose chinese currency rises by 50% ( and that is really unrealistic, I see may be 20% at most) that still doesn't make US competetive. US has to accept lower standard of living, it is the only answer in the all-equalizing global marketplace. Normally it would happen automatically with devaluation of the weaker country's currency. But with USD being the reserve currency it is really very tricky,

Another point is that every country manipulates their currency , some more some less. Japanes and Swiss being the most recent examples. Everybody wants to grow their economy via exports, but it is very hard when input cost/ labor costs are high, so every country aims to lower their currency.

I often think about the underlying problem in these discussions - loss of jobs. In a truly free marketplace workers should gop where jobs are - Asia, for example. But most unemployed americans would never even consider looking for work overseas if they lose a job. That is because the are immigration barriers in other countries (though for americans they are minimal) and also because they'd have to accept lower standard of living.

In the end, I think most imbalances result from blockages of the free market flows through various protectionaist policies by each country. Each country only cares about their citizens and often even not that but about its power. They couldn't care less about global marketplace and prosperity of other countries. So, they only do what benefits them. US is no different.

US has to accept lower standard of living, it is the only answer in the all-equalizing global marketplace. Normally it would happen automatically with devaluation of the weaker country's currency. But with USD being the reserve currency it is really very tricky,

I don't necessarily believe this would happen. I might be wrong, but I think most people are looking at this from the wrong prism.

If the Dollar is allowed to appreciate, certainly, American purchasing power will be reduced. Conversely, however, the cost of goods worldwide will drop. This might sound contradictory, but you have to realize what mercantalism does --- it creates economic inefficiences so more inefficient manufacturers drive out of business more efficient ones.

So it's true that us Americans will get hit in one way; but we'll benefit in another. Moreover, as our economy is allowed to return to normalcy (with the trade gap narrowing), there will be more jobs, which will reduce government and private debt.

So all in all, allowing currencies to normalize will cause some hardships, but it will be beneficial in the long-term.

Also, there is a bit of myth going on here --- everyone talks about how America has to compete with cheap Chinese manufacturing. Well ... no we don't. Why on Earth would we want to produce goods that require low-skill labor? We export different products --- our focus is on higher-skilled labor, technology, and automated production; not low-quality goods that need cheap low-skilled labor.

America's labor productivity is light-years ahead of China, so realistically speaking, our competition with China is limited. Rather, the nations hurt by China's trade practices are places like Vietnam, Mexico, and Latin American nations; not the US. The US needs to compete with higher-technology nations like Germany, Finland, Austria, Japan, and the Netherlands--- China has a long ways to go to compete with the US or any of those nations in terms of labor producitivity.

The problem is that the U.S. is not even manufacturing the higher-technology items. The U.S. may be the place where things like the iPhone are designed, but it's being manufactured in places like China (with massive companies like Foxconn).

> The US needs to compete with higher-technology nations like Germany, Finland, Austria, Japan, and the Netherlands--- China has a long ways to go to compete with the US or any of those nations in terms of labor producitivity.

US cannot compete with (or imitate) these boutique countries simply because of its scale. US culture, education system, scale is so completely different. Russia is closer to these countries culture and education wise than US and that is saying something. US is more like Latin America in my opinion. May be we should look to Brazil for inspiration.

> If the Dollar is allowed to appreciate, certainly, American purchasing power will be reduced. Conversely, however, the cost of goods worldwide will drop. This might sound contradictory, but you have to realize what mercantalism does --- it creates economic inefficiences so more inefficient manufacturers drive out of business more efficient ones.

If dollar rises, I think the american purchasing power increases but exports competitiveness drops. Sort of what we have . But now we ( government officials) want USD depreciate, right to make US more competitive? That means americans having to buy imports at higher prices and that means poorer americans, lower standard of living. May be I don't understand what you are saying.

You're missing the point. Manufacturing iPhones is relatively low-skill. The media has focused on China's low-cost labor, but we're not really competing against their low-cost labor on any meaningful level. They are competing against Vietnam, Mexico, and other nations with similar economic situations; not the US.

Labor productivity is a vastly more important measure than labor wages. Take a glance at the current account figures and notice which countries are amongst the leading exporters:

Germany

Sweden

Norway

The Netherlands

Finland

Austria

Germany has higher wages than the US. Sweden, the Netherlands, and Finland are comparable.

If your logic is correct, then why are there nations with higher wages than the US that are exporting more than China? The reason is simple: labor wages aren't that important. Labor productivity is everything.

Sure, the US is not going to get back its shoe-manufacturing business, but it doesn't need it.

Take a look at what Germany exports and that's what the US is competing on. We don't want low-skill manufacturing. We want to export services, automobiles, heavy machinery, textile, pharmaceutical products, food, consumer electronics, microprocessors, etc.

The trade imbalances aren't the result of 'high US wages' because if it were, then Germany, Finland, and Sweden would all be in the same boat. The imbalance results from currency distortions. Without these distortions, the market will find a proper balance.

I didn't finish this thought. I think Brazil is sort of like US for the 19th century. Lots of natural resources, little use of credit so with better access to credit comes huge wealth expansion. No, I don't think US can use Brazil's recipe unless it wants to go backwards. But even if US wants to imitate Germany - it means higher taxes and lower standardx of living. Nobody in Germany lives in McMansions. They use public transportation, and eliminate waste everywhere they can. US is very wasteful is now living is organized. But I cannot see americans abandoning suburbs and rebuilding abandoned cities so that they can live in tiny flats, spend less on utilities and cars and gas. I just don't see it.

You are essentially arguing that free markets do not work. That the only reason for the US's success is artificial distortions. Yet, by subscribing to that view, you are implying that mercantilism creates optimal economic growth.

This goes all the way back to Adam Smith. Smith argued that by enacting trade protections, everyone was worser off. If the trade protections were removed, the most efficient producers would win out, which would lower costs and increase wealth for everyone.

Smith was right. This is a replay of the mercantilism of early modern Europe. Spain was the biggest mercantilist power of the day and it basically starved its citizens via trade protections. China is doing the exact same thing right now. Spain eventually went bankrupt and the UK, Europe's most liberal power, ended up being the dominant European economic power by the 19th Century.

This is no coincidence. And the scenario before us is not all that dissimilar. So long as China and Japan keep manipulating currencies, they will distort the markets and force a less efficient result. This inevitably leads to low economic growth and even economic contraction. It prevents interest rates in the US from rising to 'market levels' and this means the banks continue to be unprofitable.

There's no reason the US cannot compete with the rest of the world. We have the most innovative entrepreneurs in the world. Every year, we scoop up some of the brightest minds from places like India, China, Africa, Eastern Europe, etc.

It's sheer nonsense to say the US can't compete. This idea has been engrained into people's heads because they can't ever remember the US being competitive on exports --- but they fail to realize that the major reason why the US is not competitive is precisely because of an artificially strong currency.

If you really want to see how much currency issues can affect a nation's current account, take a look at the UK versus Germany. Both nations are similar in regards to wages, productivity, culture, political system, etc.

The only major difference between the two:

(1) Germany has adopted an articially weak currency, the Euro. The Euro is a 16-nation currency peg. It has weakened the currencies for Germany, Finland, Netherlands, and Austria; while strengthening the currencies for Greece, Spain, and Portugal.

(2) The UK uses the Pound Sterling, which is effectively tied for the world's 3rd most important reserve currency (with the Yen).

Two nations with very similar attributes (with the exception of currencies); two very different results. It's not a coincidence. Currency distortions are the primary driver behind trade imbalances and trade imbalances create economic inefficiencies.

> It's sheer nonsense to say the US can't compete. This idea has been engrained into people's heads because they can't ever remember the US being competitive on exports --- but they fail to realize that the major reason why the US is not competitive is precisely because of an artificially strong currency

I don't know. I remember when USSR failed and nobody knew what to do and where to earn money because most of the production stopped we kept hearing from the free market economists a tIMF and such that this is just because russians lived under socialism too long and are not enterprenerial and rely to much on the state. We just need to get out there and start cranking up new businesses and taking risks. It did actually happen eventually but before that things got really really bad.

The point of the story is that an average americans relies on the state much more than russians ever did. every russian fasmily I knew had their little plot of land rented from the government so that they could grow their own food on the weekends. That is after working fool time at the state run farm/ factory/ college/ research instute etc and all work was done with bare hands. Yep, PHDs gre their potatoes and tomatoes. I don't see anything like that in the US. People just get food stamps. That is why one of the reasons US is uncompetetive. I dont' really buy this "US is the most enterpreneurial country" thing. To get back to the enterprenerial spirit americans gotta become really poor and hungry again.

The other reason is labor too costly and needs top become cheaper.

I don't know where I am arguing agianst free markets, I don't. The reason for US succsss is the drive and hard work and sucrifice of the previous generations.

What I am saying is that devluation of chinese currency might help but only at the margin. Solving of american probelms should begin in America and it is not being done. Actually, it seems US is doing everything possible to prevent free markets from working with various stimiuluses, housing programs, crack downs on immigration and now blaming other countries for its problems.

> If you really want to see how much currency issues can affect a nation's current account, take a look at the UK versus Germany. Both nations are similar in regards to wages, productivity, culture, political system, etc.

I have to disagree, the UK and Germany are very different in every way. UK is very much like US, UK is our future.

I am in favor of a gold standard or a gold/silver standard for money around current prices, to help eliminate foreign exchange game playing and massive deficit spending that will bankrupt most of the western, industrialized economies the next 2-3 years.

I completely agree we have a real currency devaluation game starting to play out, where each export dependent economy (Euro, U.S., Japan, China, etc) tries to push their currency lower to help trade increase. This situation is another outcome of BEN's insane ZERO forever policy that is starting to backfire royally.

At some point we must realize a period of many years of economic stagnation and paying down of debts is the only "honest" way out of the huge consumer and soveriegn debt problem seen today. We should not fear slow growth rates, but instead the repercussions of out-of-control government spending and money printing. As of yet, few understand the mess for 2011-2012 that is being created TODAY by keeping our heads in the sand and pretending all will magically be well soon!!!!

Investors, consumers and businesses lack confidence in our government leaders to do the right thing... Actually, higher interest rates to increase savings in America and lower deficit spending to support the Dollar's value, are the only credible way out of this mess, from my studies.